The return of the mega deal

July 2014 | COVER STORY | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

July 2014 Issue

The total value of announced global mergers and acquisitions is at its highest level since 2007, hitting $1 trillion by April. Though there are fewer deals overall, transactions are growing larger, and the trend is apparent across many sectors. The past five months have seen Facebook acquire WhatsApp for $19bn and Comcast offer $45bn for TimeWarner. GE and Siemens continue to throw cash at French rival Alstom, and AstraZeneca came under siege from Pfizer. Though some analysts are excited about the return of the mega deal, others are more cautious. Is this a trend to stay rather than a short term spike? Or could managers be pursuing larger deals to cover up a lack of real growth opportunities?

Current trends

Uncertainty in the global economic outlook continues to influence deal activity. Though the value of global takeovers reached $1 trillion by the end of April, in the first quarter the number of deals dropped by 14 percent – the slowest year-to-date period for dealmaking since 2003. The total value for the first three months came in at $710bn, meaning the market was driven by fewer, but much larger, transactions. Indeed, almost half of Q1 M&A value came from deals topping $5bn. Transactions with price tags of $500m and above accounted for 81 percent of total announced deal value, according to The Jordan, Edmiston Group.

Activity generally has been patchy, accelerating in some sectors and slowing in others. But the strong showing of mega deals may indicate growing confidence among executives. “M&A activity has certainly heated up globally in certain sectors, especially pharmaceuticals, life sciences and telcoms,” says Tom Williamson, a partner at Deloitte Consulting LLP. “Some big deals are skewing the underlying data, which remains uneven. Much activity continues to tie to the economic outlook and business confidence, which is probably stronger in the US than most places outside China. Many companies remain relatively constrained for organic growth or view M&A as a strategic differentiator, and PE money remains plentiful.”

Today’s bumper offerings are driven by a wide range of factors. For instance, historically high levels of cash on corporate balance sheets are finally being put to work and shareholders are demanding a return on their investment. ‘Stuffing the corporate mattresses’ is no longer an option. Increased shareholder activism is reshaping corporate strategy, with boards and management under pressure to provide clear forward-looking strategic direction. In addition, interest rates remain at historic lows, supporting attractive financing conditions. Equity capital markets are also robust. Private equity firms are sitting on large pots of cash, and are now actively looking for the right opportunities. Banks have also resumed leveraged finance support for PE acquisitions.

The current proclivity toward larger deals is perhaps partly driven by the recession. The financial crisis put paid to many potential transactions, which are only now seeing the light of day. “We suspect that the market has benefited from an ‘overhang’ of deals which did not happen in the recession but where there is confidence to proceed with them now,” explains David Raff, a partner at DLA Piper. “We are certainly seeing more US purchasers back in the market. On the private equity side, secondary buyouts remain an extremely important exit route.” The current surge has certainly come later than expected. Since 2011, bankers have been predicting a return to the boom times of M&A, citing the build-up of cash on corporate balance sheets, low interest rates, and the economy’s strangulation of organic growth. However, CEOs are certainly no longer wary of making big deals, and now face the pressure of being beaten to opportunities by their rivals. “The stars are aligned for the resurgence of the mega deal,” says Richard D. Smith, a partner at Reed Smith LLP. “Many CEOs and boards now have the confidence to undertake very large, transformative deals.”

Even the deals that haven’t come to fruition have highlighted a change in the thinking of chief executives, who are more confident that economic growth has turned a corner. Barrick Gold Corp. and Newmont Mining Corp. called off merger talks that might have led to the largest mining-industry transaction since Glencore and Xstrata Ltd. merged in 2012. Similarly, Publicis and Omnicom, two of the world’s largest advertising firms, scrapped a merger worth $35.bn, which would have created a giant in the advertising industry. The proposed merger was expected to help the two firms respond to the threat of new platforms such as social media. Although they ultimately failed to complete, such deals show that CEOs, who are feeling more confident about global stability and the economy, are starting to place bigger bets.

Sector specific

The uptick in activity can be seen across industries, but has been particularly focused in the pharmaceuticals and life sciences sectors, as well as telecoms and technology. In recent weeks, US pharmaceutical giant Pfizer walked away from its efforts to woo British drugmaker AstraZeneca with a final offer of £69bn. The British firm believed the offer undervalued the company and its prospects for growth. Meanwhile, Pfizer came under pressure from the UK government, and unions, over its commitment to British research and jobs. Other firms have had more success, however. Bayer agreed in early May to pay $14.2bn for US rival Merck’s consumer care business. As a result of the acquisition, the German firm expects to become the second largest player in non-prescription, over-the-counter products. In addition, in April Eli Lilly and Co announced it had agreed to acquire the animal health unit of Swiss drug manufacturer Novartis AG for $5.4bn.

On the technology and telecoms front, the headlines have been dominated by Facebook’s $19bn purchase of WhatsApp, in what will be the social media giant’s biggest acquisition to date. With WhatsApp approaching the 500 million user mark, it is little surprise that Facebook scooped up its fast-growing rival, though the price tag surprised many. It has also stoked fears of a second dotcom bubble. While the cost of Facebook’s purchase raised eyebrows, many almost choked at the news that AT&T had acquired US satellite TV provider DirectTV for $49bn. The deal will see AT&T gain DirectTV’s 20 million subscribers and a company with strong cash flows. However, the news has raised concerns about competition and consumer options. Similarly, Comcast’s planned $45bn acquisition of rival Time Warner Cable has caused consternation. The deal would create a company that controls three-quarters of the US cable industry, and has come under close scrutiny by US regulators and industry competitors alike. Both the New York Times and the owner of Netflix have spoken out about the potential deal.

While these sectors are not the only ones to see dealmaking accelerate, they have provided the majority of mega deals. However, a number of active industries are unlikely to see such bumper transactions, due largely to regulatory intervention. “In the banking space, continued disposition of non-core assets and businesses due to regulatory and capital pressures will drive deals which will present attractive opportunities for well-positioned buyers,” says Mr Smith. “And there will be continued bank consolidation as smaller players look to combine with stronger, better capitalised financial institutions. However, we don’t expect to see mega bank deals in the near term, as regulators haven’t been supportive of the biggest banks getting materially bigger.”

The bulk of the deal action continues to take place in the US, which, up to the end of May, had captured 51 percent of the market by value. However, Europe and Asia-Pacific are catching up, with 24 percent and 16 percent of the market respectively. To date, 2014 has been a particularly good year for the Asia-Pacific region, which, with announced deals worth $113bn and 1751 transaction, has seen the strongest start to the year on record, according to Thomson Reuters data. “The US is seeing significant activity, with a sizable number of proposed deals having a tax inversion element, where companies are looking to improve their tax position by incorporating outside the US,” says Mr Williamson. “Cross-border activity in Europe remains weak, while the economic challenges in Brazil cast a broad shadow over Latin and South America. South-East Asia, in particular China, remains reasonably active.”

In addition, the last 18 months has seen a surge of transatlantic activity, including GE’s $17.1bn offer for Alstom’s energy division, Liberty Global’s $23.3bn buyout of Virgin Media, and Pfizer’s failed AstraZeneca bid. This comes as US companies look to take advantage of Europe’s recovery, or, in the case of Pfizer, redomicile to a lower tax jurisdiction. In addition, compared to many of their US and, increasingly, Asian rivals, today’s European firms look particularly weak, making them more likely prey for a foreign rival.

Good signs?

On the face of it, the tidal wave of mega deals appears to be a good sign. After years of lacklustre M&A activity, some dealmakers are encouraged by what they see as the first rays of light following a dark winter. However, just last year, industry insiders hailed the bumper buyouts of Dell and Heinz as the start of a new wave of M&A. They were proved wrong – 2013 went on to be an average year at best, supported largely by the surge of deals in the final quarter. The cold fact is that the number of deals is down, and the question is whether today’s mega deals really do signal growing confidence among executives, or if deal numbers and volume provide a more reliable indicator of appetite in today’s market. “Mega deals reflect confidence by those doing the acquisitions, but things remain relatively disciplined, with few bidding wars breaking out,” says Mr Williamson. “That said, the number and volume of deals remains below historic highs, reflecting economic uncertainty in many parts of the global market. At best, the global recovery remains challenging, with much of Europe and Brazil being especially weak.” The disparity in activity between sectors is also an issue. Confidence is returning to some sectors, but not all. Mega deal activity is therefore representative of only a portion of industries and firms.

On the other hand, the fact that fewer deals are being completed may not be an entirely negative sign. Today’s firms are putting a much greater emphasis on good corporate governance, and stakeholders and regulatory bodies are carefully evaluating pending acquisitions. The current M&A slowdown may well be a result of the fact that only the better conceived deals are coming to completion. In the long term, this cannot be a bad thing.

The notion that today’s deals are being executed more rationally than in previous years is backed up by the unified and supportive front investors are showing toward what they perceive as more measured purchases. In the past, it was almost universally the case that the share price of companies making acquisitions declined on news of the deal. That trend has started to turn in the past two years. On average, the share price of acquiring firms gain 4.4 percent within a day of a deal being announced, according to Dealogic.

Going forward

Whether or not the M&A market is currently bullish, many commentators expect it to explode into growth at any point. And, with the right conditions seemingly coming together, they may soon be correct. Most of the economic fundamentals such as cheap debt, high stock market valuations and cash on the balance sheet are typical drivers of M&A activity. In addition, organic growth remains difficult in the current economic environment. “As long as there are no major political or economic disruptions, this trend should continue throughout 2014, with the momentum building on itself, including increased M&A volume in the middle market as deal fever spreads,” says Mr Smith. “However, one final caveat remains – antitrust approval. This could constitute a potential stumbling block for some transactions, although mandated divestitures coming out of the antitrust review process could result in appealing opportunities for certain strategic and private equity buyers.”

Whether the mega deal trend will continue is a different matter. Not only is it dependant on the performance of a narrow band of sectors, it also relies heavily on investor sentiment and the economic environment, which, although improving, remains unstable. Furthermore, the current spate of mega deals may prove an anomalous trend that peters out of its own accord. Despite this, their recent appearance may be doing much to bolster confidence throughout the economy. “Our pipeline looks extremely healthy but we should be cautious that the effects of tightening up previously loose monetary policy in the US and elsewhere might have a negative effect on sentiment,” says Mr Raff. “There are only so many mega deals that can be concluded, but my sense is that they send positive sentiment coursing through the market, which has a knock-on effect further down.”